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Rathbones: the 2013 challenges and opportunities in six key areas
by David Coombs on Dec 06, 2012 at 14:03
Rathbone's head of multi-asset investments David Coombs takes a tour of the world to identify where the challenges and opportunties lie across six key areas.
Our base case scenario is that whilst a number of headwinds remain, economies and markets may surprise on the upside, especially in the US. In the last quarter of 2012, expectations have been so subdued, that the only way is up. Central bankers have been explicit in their willingness to uphold economies, and we expect their coordinated responses to continue.
We do believe, however, that unless there is an ‘ice age’ scenario, and with the potential for debt cancellation (what we would term as “QE4”), and therefore subsequent inflation risk, the central banks will not be forthcoming in their implementation of more QE.
In 2013, a deflationary scenario is unlikely, but remains a risk that markets will worry about. Instead, we see sub-trend growth and a small pick-up in inflation. Over the next three years, we see investors fretting about an inflationary environment, peppered with periods where fears of deflation take precedent. In 2013, investors should expect a year of greater market volatility (technically, volatility in 2012 has been very low, although it has not always felt like it!).
All things considered, we believe the management of volatility and risk in portfolios will assume a much greater significance.
US growth is stronger, as evidenced by the upward revision of US Q3 GDP, and we expect this to continue to gain traction. We see a resolution to the US ‘fiscal cliff’, despite the political brinkmanship of late, as the alternative is too horrendous to contemplate. The ‘cliff’ may creep into 2013, but much of the news has been priced-in. We believe a bipartisan agreement will be reached. Indeed, with company forecasts overly-pessimistic, we believe there is room for significant earnings surprise on the upside. Furthermore, the continuation of the US Federal Reserve’s bond-buying programme should benefit sentiment and therefore risk assets.
Lately, investors have been too bearish, although we are also inclined to revise down our growth forecasts to 6-7% - still strong, but more akin to a normalisation of expectations. We believe China’s version of authoritarian capitalism is unsustainable in its current form; indeed, we would go so far as to say that China could become ungovernable in its current incarnation over the next 10 years, with a recent field trip revealing, (albeit anecdotally), signs of militancy in the private sector. The Gini Coefficient, a measure of income in equality, is at its highest level since 1949. Social discontent is a real issue, and how the new regime choose to address this will be as crucial for domestic politics as it will be for international perceptions. The regime’s focus on rudimentary healthcare is likely to be positive for pharmaceuticals.
Europe seems to be boring investors into submission. Indeed, the debate around Greece’s debt is no longer a market-mover. Any resolution in Europe will mean a ‘hair-cut’ for peripheral bond-holders and Germany taking more of a financial hit. President of the European Central Bank, Mario Draghi, has done a tremendous job with regards to talking down bond yields (at the time of writing, Portuguese and Italian 10-year yields are close to two-year lows), without any money exchanging hands. The European ‘event’ next year, barring any nasty surprises, will be the German election in October. Between now and then, Chancellor Angela Merkel has an even more intricate balancing act to perform, between domestic objectives and broader European interests. If she wins, she will have time to allow her to follow less populist action and support the Union - something that will be very positive for market sentiment.
By extension, if the worst case scenario in Europe is avoided, the UK will experience a much-needed palliative (by worst case, we refer to the collapse of the euro). Otherwise, the economy is likely to stumble along an uninspiring growth path. We view the revised Q3 GDP figure of 1% appears as somewhat of an exception, and figures into 2013 are still vulnerable to technical anomalies. We would like to see the chancellor curb rising taxes, which are eroding consumer spending power, already under pressure from inflation rates, well above earnings’ rises. We do expect a dislocation of the economy and stock market in the UK, with FTSE returns of around 5%-6%.
Gilts have little intrinsic value these days, but they can offer protection against falling equity markets. Furthermore, low nominal spreads look very vulnerable. We favour exposure to gilts in the long duration space, which tend to have a lower correlation to equities, and thus provide us with a good diversifier. Current spread levels do not provide a buffer from any inflation surprises, especially if governments decide to cancel debt – something which we believe there is a high possibility next year - or if issues persist in the Middle East. We would therefore look to buy into index-linked gilts.
Equities: The move from ‘RoRo’ to ‘RaCy’
We are constructive on equities and will selectively increase our exposure. Indeed, we expect more of a dislocation between equity markets and economies, whereby market could still move higher next year, despite macro-headwinds. Equity volatility has technically been quite low; however, this is something we expect to rise next year, which could lead to violent rotations in sectors. This will see the shift from simple RoRo (Risk-on/Risk-Off) movements to RaCy (Rapid Cycling), where cycles will be quicker and much more pronounced. We favour US equities over the UK, and emerging markets.
Most bullish on countries making up the Association of Southeast Asian Nations (ASEAN), although this is consensual amongst a number of Asian managers in which we are invested, and valuations are not cheap. Aside from these well-publicised structural drivers of excellent demographics, growing disposable incomes and urbanisation, it has recently come to light that by 2015, this region should have agreements in place, such that people and goods can travel freely cross-border, as is the case in the European Union. Extensive high speed rail links are being built. Despite close proximity to China, we do not view this region as a China-play, as the majority of trade is intra-regional. Our preferred strategy is emerging market income.